How stablecoins can save cryptocurrencies
As the General Manager of the Bank of International Settlements (BIS), Agustín Carstens, said, “New technology is not the same as better, or more efficient technology.” However, you don’t have to be a techno-optimist to recognize that the evolution of technology is unstoppable and improvements can be expected to address things like the volatility of cryptocurrencies. In fact, solutions are already being considered for this problem, such as stable digital currency, or “stablecoins”.
In his recent speech at the Academy of Moral and Political Sciences, José Manuel González-Páramo, Head of Global Economics, Regulation and Public Affairs at BBVA, analyzed the birth and evolution of digital currencies.
In his opinion, cryptocurrencies are not a credible alternative to money in their current state. Their elevated volatility in conjunction with their use for illicit purposes, lack of robustness and efficiency impact the basic pillar on which any currency is based: confidence. The overall lack of confidence in cryptocurrencies complicates their use as a method of payment, unit of account or store of value and therefore, makes it difficult for them to be considered money per se.
However, as he explains in the op-ed published yesterday in the newspaper El País, in recent years, the private sector has developed alternatives to bitcoin, such as stablecoins, as has the public sector with the digital currencies issued by central banks, still in a more conceptual stage. This innovation process aims to reap the benefits of digitization - speed, its global, decentralized nature, lower costs, security, fraud mitigation, etc. - while minimizing its disadvantages.
Are stablecoins the solution to cryptocurrencies’ problems?
In his speech, José Manuel González-Páramo explains that “stablecoins are digital currencies built in a way that their volatility is limited by design.” He identifies two different groups of currencies based on their strategies to reduce volatility.
On the one hand, there are collateralized stablecoins, whose volatility stabilization mechanism is based on the principle of fiat money. In other words, in this type of digital currency, the value is referenced to the euro, the dollar, or any other currency or basket of digital currencies, or other material goods, like gold.
Some private sector initiatives already exist which are referenced to the dollar, for example. In principle, their use will be geared toward the payment system, helping large corporations perform international transfers more quickly. Current options, such as SWIFT, take one day or more.
In his speech, BBVA’s Executive Board Member indicated that those issuing this kind of stablecoins generate tokens that they sell to users, giving them certain rights over the collateralized assets (euro, dollar, gold, or other assets).
He also underscored that stablecoin issuers must deposit the collateralized assets in traditional financial institutions, which makes it easier to track and supervise these new actors. The survival of digital currencies of this kind is based on the confidence that the custodian has the assets that back the issuing of tokens at all times.
In this regard, 100 percent of collateralized stablecoins can be considered digital currencies under European legislation, and are therefore subject to the supervision of competent authorities, such as the European Banking Authority (EBA). Currently, collateralized stablecoins represent around 80 percent of all digital currencies of this kind. Among them are Tether and TrueCoin - both backed by the U.S. dollar and managed by respective companies that act as a central institution. Another example of this kind of digital currency is G-Coin, a platform of tokens that are equivalent to a gram of gold.
On the other hand, there are also non-collateralized stablecoins whose value is determined by mathematical algorithms that control price fluctuations, issuing more digital currency when the price rises and viceversa when the price declines.
A total of 57 stablecoin projects were identified in 2018, 23 of which are starting to take their first steps. Stablecoins are a clear example of a dynamic innovation process that will definitely continue in the years to come. Although they represent undeniable progress in the digital currency field, they remain in the very early stages and cannot yet be considered to offer sufficient guarantees to fulfill the three functions of money.